The Break-Even Analysis 

Break-even analysis is of vital importance in determining the practical application of cost functions. It is a function of three
factors, i.e. sales volume, cost and profit. It aims at classifying the dynamic relationship existing between total cost and sale
volume of a company.
Hence it is also known as “cost-volume-profit analysis”. It helps to know the operating condition that exists when a company
‘breaks-even’, that is when sales reach a point equal to all expenses incurred in attaining that level of sales. The break-even
point may be defined as that level of sales in which total revenues equal total costs and net income is equal to zero. This is
also known as no-profit no-loss point. This concept has been proved highly useful to the company executives in profit
forecasting and planning and also in examining the effect of alternative business management decisions.
1. Break-Even Point:
The break-even point (B.E.P.) of a firm can be found out in two ways. It may be determined in terms of physical units, i.e.,
volume of output or it may be determined in terms of money value, i.e., value of sales.
ВЕР in terms of Physical Units:
This method is convenient for a firm producing a product. The ВЕР is the number of units of a product that should be sold to
earn enough revenue just to cover all the expenses of production, both fixed and variable. The firm does not earn any profit,
nor does it incur any loss. It is the meeting point of total revenue and total cost curve of the firm.
The break-even point is illustrated by means of Table 1:
Table 1: Total Revenue and Total Cost and ВЕР

Output TR TFC TVC TC

0 0 150 0 150

50 200 150 150 300

100 400 150 300 450

1150 600 150 450 600 BEP

200 800 150 600 750

250 1000 150 750 900

300 1200 150 900 1050

Some assumptions are made in illustrating the ВЕР. The price of the commodity is kept constant at Rs. 4 per unit, i.e.,
perfect competition is assumed. Therefore, the total revenue is increasing proportionately to the output. All the units of the
output are sold out. The total fixed cost is kept constant at Rs. 150 at all levels of output.
The total variable cost is assumed to be increasing by a given amount throughout. From the Table we can see that when the
output is zero, the firm incurs only fixed cost. When the output is 50, the total cost is Rs. 300. The total revenue is Rs. 200.
The firm incurs a loss of Rs. 100.
Similarly when the output is 100 the firm incurs a loss of Rs. 50. At the level of output 150 units, the total revenue is equal to
the total cost. At this level, the firm is working at a point where there is no profit or loss. From the level of output of 200, the
firm is making profit
Break-Even Chart:
Break-Even charts are being used in recent years by the managerial economists, company executives and government
agencies in order to find out the break-even point. In the break-even charts, the concepts like total fixed cost, total variable
cost, and the total cost and total revenue are shown separately. The break even chart shows the extent of profit or loss to the
firm at different levels of activity. The following Fig. 1 illustrates the typical break-even chart.

In this diagram output is shown on the horizontal axis and costs and revenue on vertical axis. Total revenue (TR) curve is
shown as linear, as it is assumed that the price is constant, irrespective of the output. This assumption is appropriate only if
the firm is operating under perfectly competitive conditions. Linearity of the total cost (TC) curve results from the
assumption of constant variable cost.
It should also be noted that the TR curve is drawn as a straight line through the origin (i.e., every unit of the output
contributes a constant amount to total revenue), while the TC curve is a straight line originating from the vertical axis
because total cost comprises constant / fixed cost plus variable cost which rise linearly. In the figure, В is the break-even
point at OQ level of output.
In the preparation of the break-even chart we have to take the following considerations:
(a) Selection of the approach
(b) Output measurement
(c) Total cost curve
(d) Total revenue curve
(e) Break-even point and
(f) Margin of safety.
2. Determination of Break-even Point:
The formula for calculating the break-even point is
ВЕР – Total Fixed Cost/Contribution Margin Per Unit
Contribution margin per unit can be found out by deducting the average variable cost from the selling price. So the formula
will be
BEP = Total Fixed Cost/Selling Pr ice – AVC
Example:
Suppose the fixed cost of a factory in Rs. 10,000, the selling price is Rs. 4 and the average variable cost is Rs. 2, so the break-
even point would be
ВЕР = 10,000(4-2) = 5,000 units.
It means if the company makes the sales of 5,000 units, it would make neither loss nor profit. This can be seen in the
analysis.
Sales = Rs.20, 000
Cost of goods sold:
(a) Variable cost at Rs.2 = Rs. 10,000
(b) Fixed costs = Rs. 10,000
Total Cost = Rs. 20,000
Net Profit = Nil
ВЕР in term of Sales Value:
Multi-product firms are not in a position to measure the break-even point in terms of any common unit of product. They find
it convenient to determine the break-even point in terms of total rupee sales. Here again the break-even point would be
where the contribution margin (sales value—variable costs) would be equal to fixed costs. The contribution margin however,
is expressed as a ratio to sales. The formula for calculating the break-even point is
BEP = Fixed Cost/Contribution Ratio
Contribution Ratio (CR) = Total Revenue (TR)-Total Variable Cost (TVC)/Total Revenue (TR)
For example, if TR is Rs. 600 and TVC is Rs. 450, then the contribution ratio is
CR = 600 – 450/600/600=150/ 600 = 0.25
The Contribution Ratio is 0.25
BEP = Total Fixed Cost /Contribution Ratio
= 150/0.25 = 600
The firm achieves its ВЕР when its sales are Rs. 600
Total Revenue = Rs.600
Total Cost = Rs.600
Net Profit/loss = Nil
Assumptions of Break-Even Analysis:
The break-even analysis is based on the following set of assumptions:
(i) The total costs may be classified into fixed and variable costs. It ignores semi-variable cost.
(ii) The cost and revenue functions remain linear.
(iii) The price of the product is assumed to be constant.
(iv) The volume of sales and volume of production are equal.
(v) The fixed costs remain constant over the volume under consideration.
(vi) It assumes constant rate of increase in variable cost.
(vii) It assumes constant technology and no improvement in labour efficiency.
(viii) The price of the product is assumed to be constant.
(ix) The factor price remains unaltered.
(x) Changes in input prices are ruled out.
(xi) In the case of multi-product firm, the product mix is stable.
Limitations:
We may now mention some important limitations which ought to be kept in mind while using break-even
analysis:
1. In the break-even analysis, we keep everything constant. The selling price is assumed to be constant and the cost function
is linear. In practice, it will not be so.
2. In the break-even analysis since we keep the function constant, we project the future with the help of past functions. This
is not correct.
3. The assumption that the cost-revenue-output relationship is linear is true only over a small range of output. It is not an
effective tool for long-range use.
4. Profits are a function of not only output, but also of other factors like technological change, improvement in the art of
management, etc., which have been overlooked in this analysis.
5. When break-even analysis is based on accounting data, as it usually happens, it may suffer from various limitations of
such data as neglect of imputed costs, arbitrary depreciation estimates and inappropriate allocation of overheads. It can be
sound and useful only if the firm in question maintains a good accounting system.
6. Selling costs are specially difficult to handle break-even analysis. This is because changes in selling costs are a cause and
not a result of changes in output and sales.
7. The simple form of a break-even chart makes no provisions for taxes, particularly corporate income tax.
8. It usually assumes that the price of the output is given. In other words, it assumes a horizontal demand curve that is
realistic under the conditions of perfect competition.
9. Matching cost with output imposes another limitation on break-even analysis. Cost in a particular period need not be the
result of the output in that period.
10. Because of so many restrictive assumptions underlying the technique, computation of a breakeven point is considered an
approximation rather than a reality.